What is the Difference Between an LLC and a Corporation?
The differences matter!
When starting your own business, one of the first decisions you are going to make is deciding the type of business entity your company is going to be. This is a very important decision that can impact your team, your taxes, and your finances. One must remember that there are different kinds of entities, and depending on which type you choose, there are a whole lot of other factors in play. You have to take into account the type of business you have, its formality and structure, your source of investment, and what sort of tax advantages can you enjoy.
While there are many types of business entities, the two most common ones are LLCs and Corporations. You may not be aware of what the difference between an LLC and a corporation are, but in this article, we hope to help you better understand. We will explore both of these primary entities to help you decide which one is the best for your business.
Do What’s Best For Your Business.
Before we start this journey, it is important that you, the business owner, has a good idea about what they want out of their business. Factor in the requirements of your business, and its long-term and short-term goals to decide whether an LLC or a Corporation is suitable for you. You want to find the best possible structure for your company and the benefits that come with it. It is advisable to prioritize your short-term goals (if you can) as the benefits can be maximized in the first few years. A certified tax professional
Let’s start with the basics…What do “LLC” and “INC” stand for?
Upon conducting your research you would have found that businesses use abbreviations such as “LLC” or “Inc.” You will find that most businesses use one of them. You might be wondering what is an LLC? Or, perhaps you are curious if an LLC can also be classified as a corporation.
First, LLC stands for “Limited Liability Company”, a business structure that merges the pass-through taxation with the limited liability of the corporation. It also gives its owners limited liability for all company debts. Second, LLC and Inc. are literally different. “Inc.” and “Corp” indicate that a business is a corporation. A corporation is a legal entity that functions completely independent. It is separate from the people who own and control it. This allows shareholders to be not involved in any legal action as well. The corporation itself is held legally liable for the actions of the company. This also includes any and any debts.
How is an LLC Different from a Corporation?
Both an LLC and a corporation establish businesses as legal entities that exist separately from their owners. However, in the case of an LLC, the owners are called “Members”, and for corporations they are called “Shareholders”. Also, an LLC is a company but it is not incorporated. Both forms of business also provide limited liability to the company, protecting it from any employee or shareholder and whatever mistakes they might make. Despite these similarities, there are differences between them.
It can be a daunting task to decide how to go about incorporating your company and in the sections below, we shall take a look at some important differences between an “LLC” and an “Inc.”
Taxation
Perhaps the most distinct difference between an LLC and an Inc. is taxation. The type of tax entity, whether the entity is even taxable, and other legal factors all depend on how the IRS classifies the business. It can also come down to the local and state authorities to have their say in the matter. An LLC and an Inc. fall under different tax entities, but how they are formed is also important.
* Corporations: These entities can be taxed in two ways S-Corporation or C-Corporation. A C-corporation means that you have to pay federal income tax on any profits and shareholders are also liable to pay any tax on the dividends they receive. As the dividends are taxed on two levels, i.e. the corporate and the personal, this is called double taxation. S-corporations are for those that want a corporate structure with 100 or fewer shareholders. They avoid the issue of any double taxation. This is great for any business that has a high start-up cost.
* LLC: an LLC is classified as a “Pass-through” what this means is that members are allowed to pass company profits to their personal income tax, but only their shares. It only has a single layer of taxation.
Formalities
The sheer amount of formalities that one has to go through when setting up a company can be exhausting. There’s paperwork, legal documents, consulting with a lawyer and a tax prepare, filing all the necessary forms and claims, etc. Corporations have many more requirements than an LLC and thus a lot more effort is required. To turn your business into a corporation, you need to have a ledger that details all the decisions made by the business, board members, and a board meeting, at least once a year, in the state the company was incorporated in (yes, this is mandatory).
Unlike a corporation, the LLC is a relatively new concept. They are not required to keep any records, nor are they required to have annual meetings, and they do not need to keep or file any financial records that show the company’s profits and losses.
Ownerships And Stocks
In an LLC, the owners are called “members” and in a corporation, they are called “shareholders ”. In an LLC, the business can distribute the ownership stake as it wishes. They do not need to consider the member’s capital contribution to award them a stake in the company. This is important when distributing profits. Despite not putting equal contributions, an LLC’s initial agreement may state that each member gets equal profits.
This is very different for a corporation. Unlike an LLC, they can issue stocks to raise money (but cannot have an IPO), which allows investors to put money into the business. Corporations can also attract investors by issuing classes of stock and entice employees by giving them stock options. An LLC cannot do this, hurting its ability to expand, raise capital, and meet expectations.
Transferability
Another major differentiating factor is that LLCs can be terminated if a member goes bankrupt. This is not the case for corporations. A corporation can become government property upon bankruptcy. Another difference is that corporate shareholders can transfer voting rights, but in an LLC this is not an option.
Our guess is that even after reading this, you still have questions. That’s okay! We are here to answer all of your tax questions, and help you make informed decisions.
